5/26/2009 @ 1:00PM

New State Tax Rates Create Traps

So you’ve filed your 2008 tax return and were hoping you wouldn’t have to talk to (or pay) your tax accountant for a while. Bad news: If you live in California, New York or Hawaii, you might need an emergency consultation. All three states have raised their taxes on at least some residents, retroactive to Jan. 1, which can mean you’ll have to redo your estimated tax payments to the state, due June 15.

Ignore this now, and you could face a surprisingly big tax bill next April, plus an assessment for “penalties”–essentially interest, at a 5% to 8% annual rate, on the underpaid amount.

The biggest changes will hit upper income New York residents. “There are a lot of accountants scrambling around, calling their clients and telling them they are going to need to come up with more money on June 15,” says Wayne Berkowitz, a CPA with Berdon LLP in New York City.

In 2008, the highest New York state rate was 6.85%, which applied to taxable income over $40,000 for a married couple filing jointly. But in April, New York added two new brackets for 2009 through 2011. For a couple with taxable income over $300,000, or a single with income over $200,000, the rate is 7.85%; for any filer with taxable income over $500,000, it’s 8.97%.

Typically, through withholding and quarterly payments, individual taxpayers must pay 100% (or in a few states 110%) of the prior year’s tax owed or 90% of the current year’s liability to avoid underpayment penalties. But the New York politicians added insult to injury by deciding that taxpayers who want to use the 100% of prior year’s taxes “safe harbor” for 2009 will have to pay 100% of what they would have owed in 2008, had the higher 2009 rates been in effect in 2008. Got that? To use the safe harbor, you must go back and recompute your 2008 taxes.

This can be a tricky calculation, warns Jamie Yesnowitz of Grant Thornton’s state and local tax group. That’s because New York’s rates contain marginal rate bubbles–as a taxpayer’s income moves above a higher rate, he loses the benefit of the lower rate on his income below the threshold.

Here’s how dramatically estimated payments might change: A married couple filing jointly with 2008 taxable income of $600,000, who pay only through estimated taxes (meaning they don’t have regular jobs with withholding) will owe New York state $18,300 in estimated taxes come June 15, instead of the $11,300 they would have owed under the old law, calculates Berkowitz. A couple with $350,000 in income (again, relying on estimated only) will owe $8,518 instead of $6,593.

California taxpayers, meanwhile, must cope with new rules that the cash-strapped state adopted to speed up its tax collections. Along with adopting a 0.25% tax rate increase for all filers, California changed its estimated payment rules for 2009 and beyond. Instead of equal quarterly payments of 25%, California requires front-loaded payments (30% each for the first and second quarters, 20% each for the third and fourth quarters).

Plus, if your federal adjusted gross income is over $1 million for 2009, you won’t be able to use the safe harbor of paying 100% of what you owed the year before. Instead, you must be sure to pay at least 90% of what you’ll owe this year. This calls for four annual trips to your tax pro, says Claudia Hill, a Cupertino, Calif., tax adviser.

Another new wrinkle: If your estimated quarterly payments exceed $20,000, you have to send them in electronically–the state is so desperate that it can’t even wait for your check to clear. If you have the audacity to mail a check, you’ll be assessed a 1% fine on your payment. (The California tax authorities are waiving the legislated 1% fine for the 2009 calendar year to let taxpayers get up to speed on e-filing.)

Yet unlike in California and New York, nothing was done to change withholding rates, warns Ronald Heller, a tax lawyer in Honolulu. So taxpayers relying on withholding are probably going to have too little withheld, leading to a big tax bill next April. To avoid penalties, Hawaii taxpayers have to pay in either 100% of their 2008 liability or just 60% of their 2009 liability. That generous 60% safe harbor means it’s unlikely many people will face a penalty for underpayment, though they may have to scrounge for the balance they owe next April.

Even local taxing districts are causing taxpayers estimated tax pain. In the New York region, the Metropolitan Transit Authority just passed a tax of 0.34% on anyone in New York or several surrounding New York and New Jersey counties with more than $10,000 in self-employment income for 2009. That might not sound like a lot, but it all adds up. And it will be a real compliance headache with quarterly filings and estimates separate from state tax filings.

What if you don’t live in New York, California or Hawaii? Don’t get too complacent. Watch your state house–other states, including Ohio and Wisconsin, have tax hike proposals pending. Moreover, more states, as they scramble for cash, may clamp down on rules surrounding filing tax estimates, predicts Yesnowitz.